For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.

The conversation in our industry has again turned to the “commoditization” of index investing as a handful of prominent asset managers have decided to hop on the low-cost indexing bandwagon. Whenever this comes up, it makes me think of Charlie Brown.

If you don’t remember Peanuts, Charlie Brown’s friend/antagonist Lucy would hold a football for him to kick. When he ran up and tried, she would pull the ball away and Charlie Brown would go flying and land flat on his back. But Lucy would always set the ball up again and convince Charlie Brown that she wouldn’t pull it away this time. Another pratfall ensued.

Commoditization keeps coming back like Lucy with her football. This recent shift in strategy by some of Vanguard’s competitors has been accompanied by a bold sales and marketing effort that attempts to narrow the differences across firms and competing products to the exclusive dimension of cost.

Not surprisingly, we believe there is some additional perspective that can benefit the conversation.

Yes, fees are very important, but they are not everything. If costs were all that mattered and indexing were a true commodity, any blockhead could pick the right index provider. Just find the lowest price.

In that case, Econ 101 would tell us that Vanguard should probably have 100% market share in the index space by now. Low-cost investing—whether it be indexing or the more than $1 trillion of active strategies we manage—has been the ethos of Vanguard for more than 40 years.* We’ve been a low-cost leader in indexing for decades.

But while we’ve enjoyed tremendous success and manage a significant share of indexed assets, we are by no means 100% of the market. Instead, we compete in a robust market where institutions and individuals select providers based on how firms distinguish themselves across multiple factors such as: the ability to prudently track an index over the long term, providing clients with robust choices across benchmarks, the level of client service, a firm’s overall investment philosophy, and the organizational commitment to indexing. Vanguard is highly differentiated from other providers across all of these dimensions and more, and we find that most investors apply this holistic lens when selecting the right index provider with which to partner.

The robots have not taken over—indexing is still a high-touch human endeavor. The delivery of many services has been automated and commoditized in recent years. When was the last time you walked into a record store, talked to a bank teller, or relied on a human being to print your boarding pass?

While it may be tempting to think that the same application of technology can displace the human element of running an index fund, we have not seen that disruption and probably never will. Indeed, people remain one of the most critical difference across providers. The portfolio managers charged with running Vanguard’s index funds have honed their craft over decades and apply their judgment, perspective, and experience to ensuring that our products are successfully implemented in a constantly changing and evolving market environment. Index fund management is an absolutely critical competency that we maintain in-house at Vanguard—it is not a discipline we farm out to third parties, as others in our industry do.

Low-cost indexing by for-profit asset managers should not be confused with charity—there’s always a catch. Vanguard has been able to offer low-cost index funds for decades because of a truly unique corporate structure. Our firm is owned by our funds’ investors. We operate at-cost across all of our products. Our success accrues to our fund investors in the form of lower expense ratios on our funds.

As a result, each of our funds stands on its own two feet. We don’t offer index funds to clients at below the cost we incur to manage them with the hope that we can somehow cross-sell a higher-margin investment strategy or monetize the relationship in some other way. There are no loss leaders at Vanguard.

Vanguard’s main competitors in the index fund market are for-profit enterprises seeking to generate returns for their external investors—an appropriate and noble aspiration for the dominant form of corporate ownership in our society. The average operating margin for the three largest publicly traded asset managers in 2015 was on the order of 40%. Offering index funds with similar fees to Vanguard’s at-cost structure—often with a fraction of Vanguard’s operating scale—works against this goal. It can only be offset by capturing much higher-margin business elsewhere in the client relationship. If that does not occur at these firms, something has to give—and it may very well be the decision to compete as a low-cost index provider.

So I can’t help but feel as if I’m watching Lucy set up the football. However, unlike Charlie Brown, I’m confident that she will pull it away. I am also confident that the index fund industry will continue to be a competitive and differentiated market place for years to come.

* U.S. domiciled assets as of May 31, 2016.

Notes:

All investing is subject to risk, including the possible loss of the money you invest.

Vanguard provides its services to the Vanguard funds and ETFs at cost.

John Croke

John Croke, CFA, is the head of multi-asset product management in Vanguard Portfolio Review Department, responsible for Vanguard Target Retirement Funds and the overall product strategy. He also partners with Vanguard Investment Strategy Group on asset allocation for Vanguard's global multi-asset class products. Before joining Vanguard, Mr. Croke was director of pension investments at Pfizer Inc. Before that role he was vice president of equity research at Jefferies & Company. Mr. Croke earned a B.S. in economics from Vanderbilt University and an M.B.A. in finance from New York University’s Stern School of Business. He is a CFA® charterholder and is a member of the CFA Institute and the New York Society of Security Analysts.

Comments

Richard G. | June 12, 2017 6:58 pm

Mr. Croke: Another informative article.To all investors reading these blogs remember you get what you pay for.I would suggest that one should read the “fine print” before you commit any money.Vanguard has always been up front with it”s client/owners.You are never going to be exposed to a Bait and switch scenario where the company changes these “loss leaders 3 to 6 months down the road to try and recoup their money. You also had better make sure these great deals involveing the company that you are looking at maintains a fiduciary relationship with you. Anyone with a Wall street address would not be doing this.We just passed our 4th TRILLION this past January.Vanguard has allowed my wife and I to retire 8 years early.I have found their index funds to be the lowest in the world and I am enjoying my admiral shares stocks and bonds.I enjoy knowing just where I stand with Vanguard and I am enjoying the fruits of 44 years of 401k savings being invested with Vanguard.Vanguard will make me a millionaire because of their rock bottom costs and their structure of their clients being also owners of their respective funds.Good Luck to all with their respective programs!

David L. | January 31, 2017 2:23 pm

Am I correct in assuming that investing in Index Funds is about timing. I am 69 & have probably missed the boat on this one. Buying stocks has taken its toll so that’s why I am looking at Index Funds as a more stable & rewarding form of investing in the short term future I have, for return on investment that is! Markets being at an all time high appear to have fleeced the pockets of those in the know. Not so for me as I am not a savvy investor nor have I been for the 12 years I have spent riding the waves. After some study, at last, I am looking at Index Funds to try & stabilize my portfolio. Are there any short term waves left & would it benefit me to hitch a ride, say for 5 to 10 years?

Hi David. Thanks for your question! As you probably know, trying to time the markets is a failing proposition. I agree, most markets are close to all-time highs, and buying in can be scary. Buying an index fund doesn’t necessarily reduce volatility and bring stability. For example, an index fund that provides diversified exposure to the U.S. equity market can bring some stability, but you’ll still experience stock market volatility in general. The most effective way to reduce volatility is to choose an asset allocation that’s right for your time frame. The addition of bonds to your portfolio will also allow you to reduce stock market volatility without losing out on the growth potential of stocks. You didn’t miss the boat, you just need to pick an asset mix that complements your goals, risk tolerance, and time frame. Here’s a link to a tool that can help you find the best fund for your needs: https://personal.vanguard.com/us/funds/tools/recommendation. Best of luck.

Donald G. | February 21, 2017 11:41 am

To: Mr. David L.1-31-17 2:23 p.m.Sir you haven”t missed anything! I am turning 69 in two months and i plan on living another 25-30 years.If you are still working then just start or continue to dollar cost average each payday. After RMD’s start then you need to decide what you want your retirement money to do for you. If you have reached retirement and you have sufficient income from your other sources(S.S., employer retirement, taxable savings) then you may want to set up a total return portfolio for your retirement with Vanguard and grow your base each year and create yet another stream of income through index funds with Vanguard.By the way Vanguard provides a RMD service to it owners and you can sign up for this service while you are 69 and get the program set up to start the following year.They will send you a check monthly,qtrly,annually however you need it.You will have to tell Vanguard which one or more of your funds to take the RMD out of.After you enter the land of “no more earned income” you can no longer add new money to your retirement accounts.You can however manage the money that are in the account and rebalance periodically to keep your desired asset % in place.So do not feel like you have missed anything. With Vanguard it is never to late to think that you cannot improve your financial imprint! Good Luck in your program. Please call up Vanguard and let them help you to not only reach but maintain your goals while you are retired.

Mary Joan K. | December 15, 2016 9:48 pm

David M. | November 22, 2016 9:44 pm

Commoditization or Fiduciary Rule?

My company’s 401k plan now offers index funds with between 2 & 3 basis points annual expense ratio currently, which had dropped dramatically this year. The active funds’ OER have not dropped at all, in contrast. Interestingly, those index funds do not have ticker symbols but are “collective trusts” which I presume is to work around any “most favored nation” contract clauses. From the perspective of a plan participant, however, I really don’t see any downside. Outside of the brokerage window option, those are the only index fund choices in the plan.

Dominic M. | November 18, 2016 9:19 pm

Michael G. | November 16, 2016 4:46 pm

I have been with many financial firms over the years. In my personal experience, Vanguard is first and foremost among them all in terms of low costs and overall returns–plus top notch in customer service.

I, too, am somewhat confused by the term “commoditizing index investing or funds” Please expand on an explanation for me.

Harlan C. | November 21, 2016 11:31 am

Commodities are by definition identical and interchangeable. Any exchange-traded lot of copper, for example, is interchangeable for all purposes with any other lot, and the buyer doesn’t have to know and doesn’t care who the seller is. New cars are commodities in that a buyer of a particular model is going to get the same product regardless of who the dealer is (at least in theory). The only distinction among copper sellers or among new car dealers is price. Therefore, a buyer should determine who is selling the needed commodity item at the lowest price, all factors (such as extra fees or delivery times and places) included.
The point of this blog is that several firms have introduced index funds to compete with the huge success of the Vanguard index funds, and have marketed them in part by cutting the fees they charge and asserting that the only difference between their funds and the corresponding Vanguard funds is price (the expense fees). Vanguard’s response is (1) Our funds are still cheaper than most of the competitors’; (2) You can rely on our expense levels because they are derived from our inherently lower-cost way of operating, whereas our competitors appear to be offering low fees as a loss-leader, and are likely to raise them over time; and (3) Vanguard is especially good at minimizing their funds’ tracking errors versus the indices and works hard at it, and our competitors do not. I agree with Vanguard on all 3.

David P. | November 16, 2016 2:15 pm

The other firms’ newly lower cost funds will probably increase their charges after a waiver period or something runs out.
Vanguard’s mutual structure allows the offering of actively managed as well as index funds at some of the lowest charges in the industry.

Connie M. | November 16, 2016 12:23 pm

John C. | November 16, 2016 11:22 am

Love these blogs. Have been with Vanguard for years, over 30, and plan to stay for a long time to come; “good Lord willing and the creek don’t rise”. Trust is so important in this business and Vanguard has established it as good an any and better than most!. If you haven’t read “Thirteen Bankers” it’s worth taking the time and you’ll discover why trust is such an important factor when investing.

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.